1. Study the conditions for an item to be treated as an ASSET for accounting purposes.
2. Indicate which of the following items should appear as an asset on the statement of financial position (balance sheet) of a business. Jot down your reasoning:
Answer 1 (adapted from Atrill and McLaney (2011, p37))
a) £1000 owed to the business by a customer who is unable to pay
Under normal circumstances, a business would expect a customer to pay the amount owed. Such an amount is typically shown as an asset under the heading “trade receivables” (or Debtors). However, in this particular case the customer is unable to pay. As a result, the item is incapable of providing future economic benefits and the £1,000 owing would NOT be regarded as an asset. Debts that are not paid are referred to as “bad debts”.

b) A patent bought from an inventor that gives the business the right to produce a new product. Production of the new product is expected to increase profits over the period during which the patent is held.
The patent would meet all of the conditions set out for an asset.

c) A new marketing director, whom the business had recently hired, who is confidently expected to increase profits by over 30% during the next 3 years.
The new marketing director would not be considered as an asset. One argument for this is that the business may not be able to sufficiently control the director. Although legally the director would be employed to provide services under an employment contract. Perhaps a stronger argument is that the value of the director cannot be measured in monetary terms with any degree of reliability.

d) A recently purchased machine will save the business £10,000 each year. It is already being used by the business but it has been acquired on credit and is not yet paid for.
The machine would be considered an asset even though it is not yet paid for. Once the business has acquired the machine, the machine is an asset even though payment is still outstanding. (The amount outstanding is a liability representing a claim or obligation that requires settlement.)

e) XYZ is considering acquiring a smaller company and after having assessed the value of the net assets in the balance sheet they agree to pay a premium of £1m for Goodwill. This premium relates to the smaller companies positive reputation, established customer based and excellent relationship with its long term business customers. £1m is agreed and paid for this Goodwill.
After the acquisition of the smaller company Goodwill can be reliability measured and therefore it can be reported in the balance sheet as an asset. As a non current asset the value of goodwill will be evaluated for impairment periodically (following the prudence convention.)

Exercise 2
The assets and Liabilities of Ben and Co LTD at 1st January 2011 are :

Inventory £22,450
Trade receivables £5,400
Trade payables £3,450
Short Term Borrowing £400
Cash £250
Bank £1,700

What is the total Equity at 1st January 2011?

Answer 2
Using the accounting equation :
Assets = Liabilities + Equity
This can be re-arranged: Assets – Liabilities = Equity

Assets = Inventory+Trade Receivables+Cash+Borrowing= £22,450+£5,400+£250+£1700=£29,800

Liabilities = Trade Payables+Short Term Borrowing = £3,450+£400 =£3850

Therefore Equity = £29800-£3850 = £25,950
Exercise 3
Fulton Ltd has inventory of £10,000, trade receivables of £2,000 and Property and equipment of £15,000 at the 30th of September 2011. The total equity recorded is £15,000 at the 30th of September 2011. What are the liabilities at the 30th of September 2011?

Answer 3

Assets = Inventory+Trade Receivables+Property & Equip. = £10,000+£2,000+£15,000=£27,000

Equity = £15,000

If Asset-Liabilities = Equity
Then £27,000-L = £15,000

Liabilities = £12,000

Exercise 4 (adapted from Atrill and Mclaney (7th edition, p68))
The following is a list of the assets and “claims” of Crafty Engineering LTD at 30th of